As a new week kicks off, we’re picking up a switch in the psychology of the market, which is shifting radically from inflation concerns to one firmly focused on growth.
Friday’s US Institute for Supply Managers’ manufacturing report showed a significant fall in new orders and employment sub-components, and while inventories rose to 56.0, the feeling is this isn’t a sign of supply chains easing, more a sign that demand is falling, and companies are stocking up their inventories.
The Atlanta Fed Q2 GDP nowcast model has US Q2 growth running at -2.1%. So, after a contraction of 1.6% in Q1, the prospect of a technical recession is now pretty high, although given the labour market is in rude health, many won’t have felt protracted economic pain yet.
However, this might – unfortunately – manifest later this year, and given we have seen 77bp of cuts priced into US rates for 2023, the implication is the market sees this as a growing probability. Presumably when we see unemployment claims showing a deteriorating trend, the Fed will take notice, but until then inflation is still its central target, and they know it is right where they want it.
Price Pressures
Traders remain anxious that the Federal Reserve has so far failed to control its balance sheet when price pressures were building and acted too slowly in raising interest rates. This implies a failure to understand the impacts of inflation on the real economy and counteracts the Fed’s prevailing view that the situation was only going to be ‘transitory’ in nature.
The market now fears that the Fed will be equally sluggish unwinding the rate rises, regardless of consumer confidence dropping like a stone and the US Purchasing Managers’ Index (PMI) heading towards contraction, with the forward-looking elements already there.
QT (Quantitative Tightening, a contractionary monetary policy that is the reverse of Quantitative Easing) is still a massive known unknown and all the modelling from PhDs will struggle at predicting behavioural issues – the fact is that liquidity is the core driver of risk, and it is fading away.
Sticky Inflation
Inflation was never going to be transitory, but high, entrenched and sticky. The market pricing of aggressive rate hikes showed the way; and they are now telling us that rates need to be cut. The question is when will bad news, by way of data releases, be seen as good news for markets?
It cannot be too far off, but it means we now must put more emphasis on growth indicators and somewhat less on the inflation story. This is key to risk management and understanding the implications of this data and how it is going to manipulate the market is critical.
Bonds are doing well in a slower growth environment; Yen [JPY] is soaring as the Bank of Japan’s dovish stance looks validated and the Aussie dollar [AUD] and copper are trending strongly lower.
Life is never boring
Life is never boring in markets, but like many, I sense the 21 September FOMC meeting could see a major direction change from the Fed. One where it is hoped they will pivot to a more accommodative stance, and this could be the trigger for a bullish turn in risk into year-end – a view the rates market is indicating and one that is becoming consensus.
It’s hard to be bullish risk when economies are slowing so rapidly, but the market is going through a change and the only thing that matters is price and reacting to moves and changes in volatility.
Happy 4th July to those who celebrate, it will be quieter than usual, although the FX and futures markets will be trading. As always keep an open mind and be prepared to react to change when trading the angles.
This article is brought to you in association with Pepperstone. All opinions expressed in this article are from the author and do not necessarily represent the opinions of The Armchair Trader.
